Question

Surya Ltd. estimates a net operating income of ₹ 1,00,000 p.a. It has 10% debentures of ₹ 3,00,000. The overall capitalisation rate is 20%. Compute the value of the firm and equity capitalisation rate according to the net operating income approach (ignoring income-tax).​

Answer 1

ANSWER :

• ❖ If Surya Ltd. estimates a net operating income of Rs. 1,00,000 p.a. and it has 10% debentures of Rs. 3,00,000 and the overall capitalisation rate is 20%; then the Value of the firm will be Rs. 5,00,000 and Equity Capitalisation Rate will be 35% according to the net operating income approach.

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SOLUTION :

❒ Given :-

• Surya Ltd. estimates a Net operating income of Rs. 1,00,000 p.a.

• It has 10% debentures of Rs. 3,00,000.

• The overall capitalisation rate is 20%.

❒ To Compute :-

• The value of the firm and equity capitalisation rate according to the net operating income approach = ?

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❒ Calculation of Value of the firm :-

It is given that,

• Net Operating Income = Rs. 1,00,000

• Overall Capitalisation rate = 20%

Hence,

• $\bigstar \: \: \tt{Market \: \: Value \: \: of \: \: the \: \: Firm = \dfrac{Net \: \: Operating \: \: Income}{Overall \: \: Capitalisation \: \: Method }}$

$\longrightarrow \: \tt{Market \: \: Value \: \: of \: \: the \: \: Firm = \dfrac{Rs.\: 1,00,000}{20 \%}}$

$\longrightarrow \: \tt{Market \: \: Value \: \: of \: \: Firm = Rs. \bigg(1,00,000 \times \dfrac{100}{20} \bigg)}$

$\longrightarrow \: \tt{Market \: \: Value \: \: of \: \: Firm = \underline{ Rs. 5,00,000}}$

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❒ Calculation of Equity Capitalisation Rate :-

We have,

• Net Operating Income = Rs. 1,00,000

• Value of 10% Debentures = Rs. 3,00,000

• Market Value of the Firm = Rs. 5,00,000

Now,

• ✠ Net Operating Income = Rs. 1,00,000

Less : Interest on 10% Debentures of Rs. 3,00,000 = Rs. 30,000

• ∴ Earnings Available for Equity Shareholders = Rs. 70,000

Again,

• ✠ Market Value of the Firm = Rs. 5,00,000

Less : Market Value of Debentures = Rs. 3,00,000

• ∴ Total Market Value of Equity Shares = Rs. 2,00,000

Hence,

• $\bigstar \: \: \tt{Equity \: \: Capitalisation \: \: Rate = \dfrac{Earnings \: \: Available \: \: for \: \: Equity \: \: Shareholders}{Total \: \: Market \: \: Value \: \: of \: \: Equity \: \: Shares}}$

$\longrightarrow \: \tt{Equity \: \: Capitalisation \: \: Rate = \bigg(\dfrac{70,000}{2,00,000} \times 100 \bigg)}$

$\longrightarrow \: \tt{Equity \: \: Capitalisation \: \: Rate = \dfrac{70,00,000}{2,00,000}}$

$\longrightarrow \: \tt{Equity \: \: Capitalisation \: \: Rate = \underline{35 \%}}$